IRC Section 199A allows owners of pass-through entities to deduct up to 20% of qualified business income, which is the net income gain, deductions, and loss from a qualified trade or business. A frequent question about the 199A deduction is whether rental income qualifies as income from a trade or business. We address it here.
Does rental income qualify for Section 199A deduction?
The IRS has made it clear in its responses to frequently asked questions that rental income will qualify for a Section 199A deduction if the rental activity amounts to a trade or business under IRC Section 162, but not if the rental is only held for investment purposes.
How to decide if your rental income is a trade or business
In Notice 2019-07, the IRS provided a safe harbor for determining whether a taxpayer’s rental activities would qualify as a trade or business.
Under this safe harbor, the owner of the rental enterprise can take a section 199A deduction if the owner spends 250 or more hours of rental service on the enterprise and meets other requirements.
Note that this safe harbor does not apply to triple net leases.
A comment on self-rentals
If real estate rental activities are rented or leased to a commonly controlled taxpayer, and the rental property is used in an operating trade or business (known as a self-rental), then the rental real estate is treated as part of the operating business.
If a self-rental is part of an operating business that the IRS has listed as a specified service trade or business (SSTB), then the 250-hour safe harbor is not required because the rental property is automatically deemed to be a trade or business.
“An SSTB is a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading or dealing in certain assets, or any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners. The principal asset of a trade or business is the reputation or skill of its employees or owners if the trade or business consists of the receipt of income from endorsing products or services, the use of an individual’s image, likeness, voice, or other symbols associated with the individual’s identity, or appearances at events or on radio, television, or other media formats.” – IRS Website
When performing the Section 199A calculation, the qualified business income, W2 wages, and wage limitation of the rental property and related business will be combined into a single trade or business. Rental real estate that qualifies as a trade or business that generates either non-SSTB income or self-rental income is automatically deemed to be a trade or business.
What about triple-net leases?
If a property is a self-rental but is leased under a triple net lease scenario, then the rental property is still deemed to be part of the commonly controlled operating business. This is because triple net leases are not precluded from being classified as a trade or business. Taxpayers are simply prevented from using the safe harbor under Notice 2019-07 to establish it.
Can I rent space to an SSTB and generate non-specified qualified business income?
Since the operating business is a specified service, trade, or business, and the self-rental income is also considered specified service trade or business, the self-rental rules apply not only to real property rentals as discussed here, but also to the rental or licensing of tangible and intangible property.
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